Markets & Finance

A Healthy Rate Rise for HMOs

April 16, 2002

By Phillip Seligman Health care is looking pretty fit these days. With a major customer signaling its agreement to a hefty hike in health-insurance premiums -- giving rise to the possibility of similar increases for other clients -- Standard & Poor's is keeping its positive outlook for the managed-care industry, which operates health-maintenance organizations (HMOs).

On Apr. 16, a panel of the California Public Employees' Retirement System (CalPERS), the second-largest buyer of health insurance in the U.S., recommended approval of a 25% increase in HMO premiums for its 1.2 million members in 2003. And this bodes well for the managed-care industry: S&P sees most HMOs obtaining higher-than-expected premium increases next year. We assume employers will widely accept the higher rates, as CalPERS is perceived as the cost bellwether for employer-sponsored health-insurance plans.

If such raised rates do become the norm, the HMOs should be better able to absorb medical cost increases and realize lower medical loss ratios -- the measure of total costs expended on health care by an insurer as a percentage of total premium revenues.

WELL-KNOWN NAME. With industry profits thus poised to improve, S&P recommends that investors buy WellPoint (WLP) and UnitedHealth (UNH), both ranked 5 STARS. WellPoint should benefit from its acquisitions of BlueCross/BlueShield plans, one of which is pending.

The BlueCross/BlueShield name is the best-recognized brand in health insurance, and it could be a powerful draw for new members for WellPoint. UnitedHealth should benefit as its fee revenues from various health-insurance-related services grow at a faster rate than those from risk-based, health-insurance premiums.

Both companies are well-managed and should see improved EBITDA (earnings before interest, taxes, depreciation, and amortization) margins because of effective cost controls.

Our other top picks in the industry include Coventry (CVH), Mid Atlantic Medical (MME), and Oxford (OHP), each of which is ranked 4 STARS (accumulate). Analyst Seligman follows managed-care stocks for Standard & Poor's